Developing Countries

1. Inequality promotes growth

After settling down around river valleys, primitive
people developed social life and land ownership. (property rights) ⇒
income inequality.

Trade promotes exchange of new ideas, technology,and
information.

(The HO model is based on identical technologies)

printing, school

When trade and learning are impeded, there will be developing
countries. Before the invention of printing, it was difficult to transmit
knowledge from one generation to the next.

Plato and Aristotle in one of Raphael's frescoes in
the Vatican Museum. (School of Athens, 387 BC)

Library of Alexandria, Egypt (322 BC?), created by Ptolemy after Alexander's
death. Destroyed around AD 391. (pagan temples were made illegal.)

LDCs copy DCs

Galleria Vittorio Emmanuele in Milan is the first modern shopping mall,
which opened in 1878. It comprised two buildings joined by an arch shaped
glass cover. This style was copied extensively in America.

China's grid plan in the 15th century BC was copied
by Japan (Kyoto).

The first shopping mall was the Markets of Trajan on
the side of Quirinal hill in Rome, opened in 112 AD. There were 150
shops in the mall.

2. Developing Countries

Advanced Nations

It is a common practice to arrange all nations
according to real income and draw a dividing line between the advanced
and the developing countries.

In the category
of advanced nations are included the countries of North
America and Western Europe, plus Australia, New Zealand and Japan.

Developing countries/

LDCs (less developed countries)

Developing countries are most of those
in Africa, Asia, Latin America and the Middle East. (South Korea, Taiwan,
Singapore and China are industrial countries at present. The argument
that China should be treated as a developing country is becoming increasingly
tenuous.

Old guard currencies ($, euro, yen)
are likely to depreciate as BRICS grow.

Brazil and China are active in Africa.

Emerging markets

One of numerous brass plates from Benin City. British Museum.

Economic growth accelerated with the printing press.

What was life like for the middle class in Europe
in the 1600s? It was much worse than that of a developing country in
the world today. The printing press had been just invented, but newspapers
were not widely circulated yet.

Economic conditions of developing countries today are
like those of European countries during the pre-industrial revolution
period.

3. Why Developing Countries Are Poor

1. Lack of Infrastructure

Developing countries have not invested enough to build
the infrastructure that enhances the productivity of both labor and capital
inputs. Infrastructure installation is costly, and hence requires a large
capital expenditure. Capital poor countries cannot afford to invest much
in infrastructure. A certain amount of infrastructure investment is necessary
to maintain the health of working population, to provide clean water and
suitable housing, etc. Lack of good highways raises transportation costs.
Urban areas grow because investing infrastructure in urban areas is more
profitable than than that in the middle of nowhere.

During the first century AD, life expectancy was a little
more than 20-30, which did not change much through the Middle Ages. The
average life expectancy rose to 47 years around 1900, and to 77 years
in 2000.

2. Lack of Skills and Technology

Laborers in LDCs are generally employed in industries
that require unskilled labor or self-employed as in agriculture. Skilled
workers are employed generally in capital intensive industries. Capital
intensive industries are located in areas with substantial infrastructure.

LDCs also are behind industrialized nations. Inward
FDI should be welcome as it brings new technologies and stimulates learning.

3. Culture

Gunnar Myrdal thought that South and Southeast Asians
are soft societies with low expectations. He said that they are lazy and
do not demand much. As a result, they do not grow. However, the rise of
Japan, the emergence of China as an industrial giant, and the Newly Industrializing
Countries (South Korea, Singapore, Taiwain and Hong Kong now graduated
from this list) as well as ASEAN proved his foresight was limited.

In France, it is almost impossible to fire a worker,
as exhibited by the outcry and sabotage of French workers to modify labor
practices. It is an indication of monopoly or monopsony power in a segment
of the society (e.g., labor union). Such a system is not conducive to
developing a flexible modern economy. Long dinner hours in some European
countries cut into their working hours.

4. Insufficient trade with the West

Developing countries do not fully exploit trade opportunities
with the West. Trade raises the wage of export sectors in developing countries.
Free trade with the west will eventually raise the wage of developing
countries to that of the West. (Factor price equalization)

LDCs can accumulate trade surplus to build infrastructure
and raise capital stock. Those who are successful in this transformation
become newly industrializing countries (NICs).

Trade rather than Aid!

5. Lack of Incentives

In the early state of development, some inequality stimulates
human desires to achieve a better life. Lack of private ownership did not
contribute much to economic growth in the former Soviet Union. The rich
or aristocrats provide a role model for the poor to reach higher income
levels. Welfare programs destroy incentives for the poor to work. In the
former Soviet Union, people were reluctant to work because pay was not linked
to work.

4. Trade Characteristics of Developing
Nations

Dependence on developed economies

Developing nations are highly dependent
on the advanced or developed nations.

Income dependence: A majority of the exports of developing
nations go to the developed nations.

dependence on Technology: Most imports of developing
nations originate in the developed countries (medicine, new machines).
Trade among developing nations is minor.

Some countries export drugs and low tech military goods
to gain international currencies.

Shares of manufactured exports tend to be less than
10% among African countries.

Labor intensive exports

Exports of manufactured goods tend to be labor intensive
(such as textiles). The absolute value of manufactured goods produced
by the developing nations is low.

The rise in manufactured goods in developing nations
is due to a handful of newly industrializing countries (NICs) such as
Korea, Taiwan, and Singapore until 1980s. However, these countries have
lost their export markets to China, which has emerged as an industrial
giant in the 1990s.

5. Trade Problems of Developing Nations

Unstable Export Markets

One characteristic of many developing
nations is that their exports are concentrated in a small number of
primary products. Dependence on primary products, 1992

6. Revenue and price elasticity of demand (PED)

There is a straightforward relationship between TR and
price elasticity of demand, PED. TR is defined by PQ, and is described
by the rectangular area generated by a point on a given demand curve.

Hat calculus

Let Z be the product of two variables, X and Y,

Z
= XY.

Let the new value of Z be denoted by Z'. Then

Z' = (X+ΔX)(Y+ΔY) = (1 + ^X)X(1
+ ^Y)Y = (1 + ^X + ^Y + ^X^Y)XY

^Z = ^X + ^Y + ^X
^Y.

When the percentage changes are small,

Z = XY => ^Z = ^X + ^Y.

Z = 1/X => ^Z = - ^X. ( ^(1/X)
+ ^X = ^(1) = 0)

Z = X/Y => ^Z = ^X - ^Y.

^R = ^P + ^Q = ^P(1
+ ^Q/^P) = ^P(1 - ε).

ε = price elasticity of demand = -^Q/^P.

Inelastic Demand.

ε < 1. Thus, ^P
and ^R move in the same direction.

ex: ε = 0.5. If ^P = -10%, then
^R = - 10%(1 - 0.5) = - 5%.

In this situation, farmers are worse off when they
harvest a good crop, because ^Q
and ^R move in the opposite directions.

Implication: A good harvest means low prices and low
revenue for farmers.

Elastic Demand

ε > 1. Thus, ^P and ^R
move in the opposite direction.

ex: ε = 2. ^P = - 10%. ^R
= - 10%(1 - 2) = 10%.

Unitary Elastic Demand

ε = 1, and hence ^R = 0.

7. Stabilizing Commodity Prices

In an attempt to stabilize export earnings,
developing countries have pressed for international commodity agreements.
ICAs are typically agreements between leading producing and consuming
nations about stabilizing commodity prices, assuring adequate supplies
to consumers, and promoting economic development of producers.

Using positively sloped supply curve, one can also
demonstrate that producer surplus is greater when prices are unstable.
Thus, producers should also prefer random prices.

However, producers are more easily organized than
consumers to persuade the government to stabilize farm prices and
that the stabilized prices should be higher than the mean prices.
They do not mind high prices, but asks the government to gaurantee
minimum prices.

International Commodity Agreement

Commodity agreements are usually made between producing
and consuming nations that want to introduce stability in the otherwise
unstable commodity markets. Agreements among producers within a single
country are usually outlawed by Antitrust laws, but such laws do not
have jurisdiction over the national territory. Thus, it is possible
to have agreements on price stabilization schemes with other producing
nations.

8. Producion and export control

How to face a global recession

Producer revenue can be riased with production
control.

Specifically, the blue rectangle can be larger than
the red rectange, which represents revenue with production control.
The area of the blue rectangle is greater than that of the red when
demand is price inelastic.

9. How to Stabilize prices

Export controls

Producers' associations have adopted export quotas.
Export quotas must also be accompanied by production control.

e.g., OPEC

Buffer Stock

A stabilization agency needs to maintain Buffer Stock.

price ceiling
price floor

Maximum price

Maximum price is a price ceiling which government imposes
to protect consumers by releasing surplus grains. Price will not rise
above the maximum price.

Minimum price

Minimum price is a price floor that government imposes
to protect producers by purchasing grains at the minimum price. The
price does not fall below the minimum price.

problems

In principle, the government can make money when
it buys grains at low price and sell at high prices.

It can be a price support program
Storage cost can be high. In the long run, profits from price stabilization
must be positive, i.e., (selling price - buying price)Q - storage cost
> 0.

Governments in LDCs don't have money to support prices.

e.g., India's protest against the elimination of a
fuel subsidy.

10. Buffer stock program

The US government set up the Commodity Credit
Corporation in 1933 to stabilize farm prices.

Farmers lobby for price stabilization, which in fact
becomes a price subsidy program.

With a buffer stock program, the government establishes
a minimum price and buys surplus grains, and sells the surplus when
price is higher.

problem

(i) The government must set aside a large amount to
enable itself to purchase the surplus grains.

(ii) The government must also use resources to manage
the buffer stock, including storage facilities.

(iii) storage cost is high.

(iv) one-year old grains are not highly valued.

11. Deficiency Payment program

Deficiency Payments

The government let the market price fall to the equilibrium
price, and pays farmers the difference d = pmin - p*. The
cost of deficiency payments program is

C = Q(pmin - p*)

Inelastic demand

Demand for grains are generally
price inelastic.

Accordingly, revenue from consumers (blue rectangle)
is smaller under the deficient payment program than under the buffer
stock scheme.

This means that deficiency payment program costs more
than the buffer stock scheme for given price ceiling.

However, there is no storage cost associated with the
deficiency payments program.

For this reason, the US government uses the deficiency
payments program, and let farmers manage the storage problem.

Supply of grains are also price inelastic.

12. Multilateral
Contracts

Long term contract that establishes price and/or quantity.
Such pacts generally stipulate a minimum price at which importers will purchase
guaranteed quantities from producing nations, and a maximum price at which
producing nations will sell guaranteed amounts to importing nations.

Life during the Middle Ages

Return from the Inn, Pieter Bruegel the
Younger (circa 1620) illustrates the farm life in a developing country.